Forex MTM of lease liability has no cash implications; will not impact normalised earnings.
We have factored Ind-AS 116 in our analysis of InterGlobe Aviation’s (IndiGo) finances and thus, introduced an ‘on balance sheet’ liability as well as a Right to Use (RoU) asset along with allocation of erstwhile rentals to depreciation and interest expense in the P&L. These capitalised operating leases (`161 bn as of Jun’18) will be marked-to-market and hence, will have a respective forex loss or gain. The MTM gain/loss will be big for
IndiGo (~change of `1 in exchange rate will drive a forex impact of `2.3 bn based on Jun’18 liability) as it has a huge fleet on operating lease (206 airplanes as of Jun’18). However, this has no cashflow effect and will not impact normalised earnings. Maintain ‘buy’ with a target price of `1,914 based on 20x FY21E P/E (unchanged).
Sheer size of fleet on operating lease will result in big forex MTM for IndiGo. Significant size of fleet on operating lease results in a significant lease liability for IndiGo (~`161bn as of Jun’18). As such, the forex driven MTM change in liability will be big for IndiGo. Addition of fleet will continuously keep increasing the liability and also the MTM impact.
Forex MTM of lease liability has no cash implications; will not impact normalised earnings. We will consider the forex MTM of lease liability to be extraordinary in nature as it has no cash implications and in real world transaction, the actual lease versus ownership equivalence is also impacted by the size of fleet, negotiations, supply/demand and interest rates.
Changing valuation methodology, we have adopted P/E-based valuation methodology (unlike adjusted EV/Ebitdar earlier) in-line with the basic principle of Ind-AS 116, which nullifies any off balance sheet item. We ascribe 20x 1-year forward multiple to IndiGo based on its high RoE (~30%) and competitive strength.
We remain positive on IndiGo for following reasons — strong volume growth with an improved international mix, improving cost advantage over peers, and organic yield improvement measures adopted by the company. Strengthening balance sheet and market share (more in the international segment) will keep improving the business salience.